How do I manage risks associated with my supply chain?

06 February 2012 -

“How should I approach a supply-chain risk-management programme for the more unpredictable risks? Can over-planning actually be less constructive?”

Professor Mike Lewis says:

The profile of supply-chain risk management has never been higher: with continued uncertainty surrounding the global economy, resource constraints, inbound inflation and the severe supply disruptions experienced in many sectors because of natural disasters – for example, the impact of the floods in Thailand on hard-disk drive production.

Although many of the tools used by purchasing and supply professionals have risk-management principles at their core, events with a very low likelihood and extreme consequences – what Nicholas Nassim Taleb has famously called "Black Swans" – are in a different class.

By definition there is an almost infinite number of very low-probability events and as a result attention paid to some – triggered by direct experience or high-profile news coverage – means that firms will then necessarily be ignoring others. For example, given the devastation caused by the Japanese Tsunami and the Thai monsoon floods it is no surprise that a recent survey of 100 executives at large multinational corporations (FM Global Supply Chain Risk Study 2011) revealed significant concerns that a large proportion of China’s industrial production capacity is located near its east coast – and therefore vulnerable to flooding.

This is not to say that this is a misplaced concern. But it is important to recall what we know about the biases associated with human decision-making processes: that we give undue weight to compelling stories, and that recent events are often associated with greater likelihood – eg, we naturally worry more about what we can bring easily to mind!

The key conclusion is that there is limited benefit associated with trying to forecast specific, extreme events. Much greater value will come from scenario planning intended to increase the organisation’s ability to cope with all sorts of consequences. Correspondingly, purchasing supply practitioners should place much more emphasis on identifying and appropriately valuing those supply options that provide genuine flexibility and/or reliability.

Professor Mike Lewis is a researcher at the University of Bath’s Centre for Research in Strategic Purchasing and Supply (CRiSPS)